Don't use retirement to pay off car loan

Dear Debt Adviser,
I have $15,000 in a 403(b) and a car loan at 4.9 percent that has $14,500 left to pay that matures in November 2013. I currently pay $548 a month. Is it wise to close the 403(b) and accept the penalties and pay off the car loan now or just let the 403(b) sit there until I retire? I am 52 years old. Thanks.
-- Rod

Dear Rod,
You're making me nervous. At 52 you are supposed to be socking away money for retirement, not spending it! And you not only want to deplete your (meager) 403(b), but you want to waste 10 percent of it while giving up a tax deferral advantage at the same time. OK, I'll calm down now.

The sad reality is that I am getting questions similar to yours from a number of people. The financial markets are uncertain. Unless you have been diversified and had the courage to stay in your investments, your retirement portfolio may be flagging. Plus, jobs are uncertain. The result is that many feel the need to do something to lower their debts. Many people want to know why they should pay more on the interest for their loans than what their investments are earning. It may seem counterproductive, but I will give you my reasons why I believe you should let your 403(b) sit.

More On Retirement:

People, perhaps including you, are planning to work longer because they haven't saved enough money for retirement. In a recent Gallup poll, it was reported that people are retiring later and later, with more than 1 in 3 workers planning to retire at age 65 or later. Only 1 in 7 planned to retire that late in 1995. Also, for the first time more baby boomers -- 53 percent -- believe they will not have enough money to retire comfortably than those who do (42 percent). In 2002, 59 percent believed they could retire comfortably with the money they had saved.

In my experience, you are better off leaving your retirement money intact for several reasons. First, once the retirement money is gone, it's gone. I know, I know, you will replace it with the money you save in monthly loan payments you no longer have to make. But, will you really? Will you consistently save your $548 (plus your regular retirement contribution) from your car loan every month for the next 27-plus months until you have replaced the $15,000?

Second, you will owe income taxes on the money you withdraw from your 403(b) account. If you are in a 25 percent tax bracket you will give up $3,750 in taxes, which will net you only $11,250. Or worse yet, the additional $15,000 could push you up into a higher income tax bracket.

Lastly, because you are younger than 59½ years old, you will have to pay a 10 percent penalty for withdrawing from the 403(b) early on top of having to pay federal, state and maybe local taxes on the withdrawal. Between the taxes and penalties, you could see nearly half of your savings evaporate. Wow.

Now, let's do the math that seemed so simple when we started. If you pay out your car loan as agreed for the next 27 months, you will pay approximately $845 in interest payments. If you withdraw the money from your 403(b) account, you will pay $1,500 in an early withdrawal penalty, say $3,750 (25 percent) in federal taxes, another $937.50 in state taxes (using my home state of Rhode Island in this example) and if you have a city tax, add that, too. That's more than $6,000 in taxes and penalties. The numbers don't lie. Keep your 403(b) funds intact.

If you want to be out from under the car loan quicker, you could pay an additional $150 per month and pay off the loan six months faster. Good luck!

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